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Why we are not paying off our debt early

Want to know something funny? We’re not only having 1, but actually 3 different forms of debt. And it even get’s worse: we choose to hold of payments on our student loans, so we can keep the money in our pockets.

But then again, we’re still money nerds and we have a good reason to do this. Paying of your debt early can be very liberating in the sense of lower expenditures and higher savings rates (or having a good night’s sleep). But in our financial journey to freedom, we try to hack for growth and the best possible return in every decision. So this one is no exception.

There are numerous articles out there which tells you how to pay off your debt in xx amount of months. And of course, having to pay a three, or four digit number every month for something we already use/own is nuts.

Last year we tweaked some minor and big things in our lives in order to increase our savings ratio, like setting a budget for groceries, eating out less and exchanged the car for a cheaper one. We managed to average our savings ratio to 40%. Which is way more than we had hoped for. So we started talking about some further spending reductions.

Our biggest monthly hurdles are the debt payments. We both have a student loan, and then we have the mortgage where we still have to pay off the astonishing amount of a little more over €250.000. Our total debt value is around € 287.178,13. You can guess that our net worth will probably be in the deep, deep reds.

Well, with this massive amount of debt, we could double our savings ratio easily once it is paid off.

There is one major reason why we wouldn’t pay off our debt earlier: the low interest rates.

For the mortgage this would be 4%, for student loan 2 this is 0.12% and for student loan 1 this is even 0%. (Yes, we literally pay no interest on this loan) And considering inflation, our student loans will actually be worth less in the future…

A little background story

In the Netherlands the mortgages are a bit different, tax-wise. Here the government has been stimulating debt over savings for many years. Only 5 years ago, you could easily fund your home with a debt having a loan to value ratio of 110%. And you would only have to pay interest, so your monthly charges remained as low as possible. Sounds a bit stupid, doesn’t it? Well, the government thought the same and changed te rules back in 2013, one year before we bought our current home.

We were offered to options: a linear mortgage or a annuity mortgage. Both are repayment models were you pay off your interest and the loan at the same time, although with a small difference.

With an annuity mortgage you pay of a lot of interest at the beginning, and having low repayments of the initial capital loan. This reverses once you getting closer to the end of your payment cycle, where you pay off more of the capital loan which results in lower interest payments. The loan duration is normally around 30 years. Your monthly payment is fixed and remains the same over the years.

But because of the tax reduction system, you will receive a bigger chunk from the government in your early years, hence lower monthly cost in the first few years of the mortgage.

The linear mortgage is set so you pay a vast amount of repayment on the initial loan. On top you will pay the interest, which will reduce over time due to since you are gradually redeeming the initial loan.

Our mortgage is an annuity form, because we had no reason (yet) to pay off as early as possible, and we were expecting an increase in income over the coming years.

Extra payments on the mortgage?

We could choose to pay off extra on the mortgage, but we don’t. This is why:

Our interest rate is set on 4% for the coming 13 years. Our average dividend yield on our portfolio is currently 3.6%. And the total return on our portfolio for the past 12 months is 37.7% (including dividends). That’s a whole lot more than the 4% interest rate we have to pay on our mortgage.

Another reason is that our interest payments will be at their highest point in the early years, the further we would come the more we would repay on the initial loan already.

Here he explains how investing could be more interesting than paying off extra on your mortgage. I came across this article recently and it perfectly portrays our decision as we went through the same thinking proces on this subject. And although past returns in the market will not provide a guarantee that the same will happen in the future years, we choose to invest our money over paying off debt.

Our plan

And this is how we aim to do it.

So, we continue to make the required payments on our mortgage. Our interest rate is fixed until 2029. We wont change or increase these payments, but leave them as they are now.

Our student debts have a duration of 15 years, resulting in a payment of about €160 every month. We paused these monthly payments for the maximum of 5 years. With the ridiculously low interest rate, our debt remains around the same. But, we have to start paying off again in february of 2022.

Until then, we ‘gain’ 160 euro every month by not paying off our student debts. Instead we save this money. Or to be exact: we place the money in index funds so it can grow more over time. Ironically, we will call this fund our Debt Fund 🙂 And with the low interest rates on the loans, this will definitely give us better returns over time. Even in a short amount of investment time.

When the 5 years are over, we will liquidate the part of the Debt Fund needed to pay off our student loans at once. Reducing our number of outstanding debts to only 1: the mortgage.

We continue to contribute in the Debt Fund after we paid off our student loans, but with a bit more than the 160 euro. For the 8 years from then, we will keep on growing this fund. We’ll calculate how much we have to invest every month in order to compensate on the outstanding mortgage in 2029.

We have a fixed interest period on our mortgage for 15 years, of which 13 still remains. In 2029, we have to renegotiate our interest rate with the bank. But, it will also give us the opportunity to pay off as much as we can at once, without paying a penalty. Which is exactly what we aim for.

We will liquidate our whole Debt Fund, which by then had some time to grow. And pay off as much as we can on the mortgage. Because we don’t know what Mr. Market will do, we have the possibility we won’t have enough to clear the whole mortgage. If there is still a bit mortgage ‘left over’, we have 3 options:

Liquify some of our dividend portfolio and pay it off at once anyway.

Pay off as soon as we can for the months/years to come

just reduce our monthly payments and pay for the remaining 15 years to come. The payments will be ridiculously low, so we won’t even notice them.

We won’t make that decision now, because we don’t know how much our Debt Fund will grow. So depending on how much money there is in our Debt Fund, we will make a decision.

Investing vs. paying off debt

This might not work out for everybody. This is our personal choice as we like to take a bit more risk in order to get more returns. We will still sleep very good at night. We are currently in a strong financial situation: we earn a solid income and can save at least 1 income every month. We have nothing to miss out on.

Paying off your mortgage as quick as possible, might give you some ease at mind. But if you’re personal situation can let you, why won’t you invest instead? Leveraging money like this doesn’t have to be a bad thing.

Keep in mind that everything in finance is personal. When having doubts on what to do, you can always ask a certified advisor for help.

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9 thoughts on “Why we are not paying off our debt early”

I understand your reasoning and indeed its a personal preference. Our mortgage interest rate is a bit higher, thats why we choose to pay it off faster, it also saves us about 1% in capital tax (vermogensrendementsheffing) and indeed gives a liberated feeling. And its risk free yield.
In either case most important is keeping the savings rate up so you HAVE a choice:)

We like to pay down debt, save, and invest all at the same time. Once a loan reaches an easy payoff amount, then we aggressively pay off that loan. But with your very low interest rates, we might make different decisions. Which is often why it is a personnel decision.

Very logical reasoning. Those student loan rates are awesome and the fact that you can freeze them for 5 years and just invest the money you would be paying while inflation actually helps you in an odd sort of way is even better.

While I do not currently have a mortgage I plan on getting my first property within the year. I would most certainly follow your reasoning as the market has been good to me and, so far, returned me greater than 4% in most cases.

It’s funny how loans vs. inflation or investing can work out. Although we never now what the future beholds there are several benefits. For us for example, we can also subtract our student loans from our taxes, so we have to pay less for our wealth tax.

Good luck on the house hunting! And keep an eye out for low interest rates 😉

This is the only part that matters “This might not work out for everybody. This is our personal choice as we like to take a bit more risk in order to get more returns. We will still sleep very good at night. We are currently in a strong financial situation: we earn a solid income and can save at least 1 income every month. We have nothing to miss out on.”

If you are happy with your plan and it fits your financial situation best, then it is a great plan in my book. You’ve clearly measured the impact of interest on your debt and the alternatives, so this wasn’t a half assessed decision. If you were paying high interest rates and were choosing not to accelerate debt payments, I may have had a different commentary. But best of luck in your plans!